Hacking the HSA for ALL the Benefits
In part 1 of the series, we discussed what makes HSAs the most tax advantaged investment account. If you missed that post, read it here first.
In the second part, we discuss 3 ways that high income earners in good health can hack the HSA account to fully take advantage of all it’s benefits.
The immediate tax savings in the year you make a contribution is nice, but the real hero is the tax-free growth of HSAs. Interest, dividends, and capital gains are never taxed even at withdrawal for qualified expenses. Maximize this benefit by contributing the annual maximum every year, and investing it for long-term growth just like you would with a Roth IRA.
For example, if you contribute $3,600 every year and use it every year, you only benefit from the immediate tax-deduction. Assuming an overall marginal tax rate of 42.35%*, that may save you around $1,500 per year. Not too shabby. But if you don’t spend your HSA and invest the $3,600 contribution instead, and assuming you can generate a 8% return for the next 30 years, the $3,600 contribution will grow to $36,225! Remember that this is on TOP of your $1,500 tax savings in the year of contribution. If you contribute and invest $3,600 annually for 30 years, you will have just over $400,000 in your HSA at the end of those 30 years, potentially enough to fund your healthcare costs in retirement.
Pay for qualified expenses out-of-pocket, but SAVE YOUR RECEIPTS on any HSA eligible expense. The IRS states that withdrawals for qualified expenses from HSAs don’t have to come in the same year. In other words, you can withdraw $500 in 2025, for expenses incurred in 2020. This can come in handy if there is an emergency in the future where you are short on cash and need to raid your HSA for cash needs. Hopefully you have a nice emergency fund and it never comes to this, but it certainly doesn’t hurt to have the option.
Should you be so lucky to be healthy late into retirement, you can make penalty-free withdrawals from HSAs for any reason after you turn 65 years old. You will owe income tax on the withdrawal, so your HSA basically becomes a traditional IRA in terms of tax treatment, but that should afford you plenty of football game tickets, hot dogs, and beer for your enjoyment like this guy:
HSA provides tremendous benefit for everyone, but it can be especially beneficial for high income earners that don’t need to use their HSA for medical expenses. A recent Morningstar study showed that the average American will need to have saved $280,000 for healthcare cost in retirement. That’s a lot of money… but here is a practical example of how an HSA can help get you there:
Save the maximum allowed to an HSA every year from ages 25 to 39 while on a high deductible healthcare plan, since presumably healthcare needs are generally lower at a younger age. In 2021, the maximum contribution to an HSA is $3,600 for singles, but the limit increases slightly each year indexed for inflation (let’s assume 3% for this example). Say you have kids or have more healthcare needs starting in your 40’s where it makes sense for you to switch to a traditional healthcare plan. You can no longer make HSA contributions but that’s okay. Keep your HSA invested aggressively so it continues to earn 8% annual average returns for the next 20 years until you retire at age 60. Your HSA at this growth rate is expected to be worth $545,650! This is more than enough but given you are retiring at age 60 instead of the Social Security definition of retirement at age 67, you’ll need a bit more in healthcare savings to get you through retirement.
Healthcare costs can be a scary thought for retirees, especially if you plan to retire early, but you don’t have to go at it alone. Take advantage of the HSA and all its benefits to the max, and make it a partner to fund your personal healthcare retirement fund!
*35% Federal + 5% state + 1.45% Medicare tax + 0.9% Medicare surtax
